Interview with Janet Yellen

When Janet Yellen was appointed to the Board of Governors
last summer, she brought academic credentials from some of
the best schools and a long list of published articles, and
her analytical talents were praised as "second to none" by
one senator. However, while she has made her mark in her new
position as a central banker, she has also earned another
reputation at the Boardshe is considered among the most
approachable of the governors.

Yellen's effort to interact with the staff not only reflects her nature, but also the value she places on talking with staff about all sorts of issues. "I enjoy hearing the details," she says in the following interview. "I don't want to just see the bottom line, the summary."

That attitude is reflected in Yellen's comments regarding monetary
policy, in which she not only stresses the importance of stable prices, but
also the need to focus on more than just numbers: "Why are we in this
business? It seems to me that it's to promote the well-being of American
households. That's what it's all about."

On the following pages, Yellen also discusses politics, bank
regulation, Fed research and her family's inclination toward economics.

Region: As a Fed governor, you seem to have a low public profile.
Is that true and if so, is that by design?

Yellen: Communicating with the public
about the state of the national economy and explaining the rationale
for monetary policy is an important part of a governor's job. Most Americans
understand very little about the Federal Reserve and how it carries
out its duties, and I think there is a real need for public education.
I have given quite a few speeches, primarily concerning the economic
situation and monetary policy, and have talked about these same topics
with the press, on the record. So in that sense, if I have a low public
profile, it's not intentional.

But frankly, one of the more difficult aspects of this job is trying
to strike the right balance when it comes to talking about the current
economic issues. Markets hang on one's every word, sometimes reading too
much into what one says and quoting things out of context. During the last
several months, for example, I have consistently voiced concern that there
are two risks as we go forward: On the one hand, there is the risk that we
have not tightened enough, so that inflation may rise; and, on the other
hand, there is the risk that we have tightened too much, and the economy
may end up slowing more than we would ideally like. I am concerned about
both of these risks. But I often find that one or the other but not both of
these statements is quoted, giving a highly biased sense of my overall
outlook. There are times, when markets are particularly unsettled, that it
simply makes sense to avoid commenting on a particular issue, like the
movement in the dollar, to avoid adding to the turbulence. In this regard,
discretion is the better part of valor.

Region: In your Senate confirmation hearing you pledged to craft a monetary policy geared toward maximum employment, stable prices and moderate long-term interest rates. Do you find any of those goals paradoxical?

Yellen: Those are the goals enunciated in the Federal Reserve
Act, which is the Fed's primary legislative mandate. I might have
phrased the directive a bit differently had I been charged with
drafting it, but the goals are by no means paradoxical to me,
because each goal reflects a sensible social concernwith
inflation, with jobs and with the cost of borrowingaspects
of economic performance that monetary policy affects.

The problem with the mandate is that it gives no guidance to
the Fed about how it should call tough tradeoffs if not all of
the goals are simultaneously attainable. Like most mainstream
economists these days, I think the "natural rate theory" fits
the data for the United States reasonably well, suggesting that
there is, to a first approximation, no long run tradeoff between
inflation and employment. In this sense, there are certainly limits
on what the Federal Reserve can accomplish through monetary policy.
While I would not push the theory too far, because fashions in
economics change, I would agree that the Fed probably cannot achieve
permanent gains in the level of employment by living with higher
inflation. But the Federal Reserve can, I think, make a contribution
on the employment side by mitigating economic fluctuationsby
stabilizing real activity. I thus translate the "maximum employment"
proviso of the Federal Reserve Act as a mandate for the Fed to
lean against the wind, stimulating the economy when the economy
is in recession or unemployment is clearly in excess of the NAIRU
(the non-accelerating inflation rate of unemploymentthe
minimum rate of unemployment consistent with stable inflation),
and restraining the economy through tighter policy when economic
activity is pushing against the limits of capacity with inflationary
implications. This is what the Federal Reserve has traditionally
done and it is what I think the Fed should continue to do. There
is no tradeoff in my view between this stabilization objective
and the objective of price stability. We can achieve whatever
inflation rate we desire, on average, while acting to stabilize
the economy.

Turning to the goal of moderate long-term interest rates: Long-term
nominal interest rates depend on the long-term real rate, which
reflects the saving and investment decisions of households, firms
and governments, and is largely outside the Fed's control, and
inflationary expectations, which are very much in the Fed's purview.
If the Fed is successful in attaining price stability it will
contribute as much as it can to the goal of moderate long-term
nominal interest rates.

Region: At that same hearing, you said, "I hope to keep
my eye on the people behind the numbers." With monetary policy
such a blunt instrument, can you really do that?

Yellen: I made that comment in response to a statement
by [then] Sen. Riegle about rising wage inequality in the United
States. He pointed to one of the most disturbing and fundamental
long-term secular shifts in the American economy that we have
seen in recent decades. American workers have faced serious difficulties
in the labor market since the first oil shock in 1973. Since that
time, the pace of productivity advance has slowed for reasons
which are still not understood, lowering the rate at which living
standards have advanced. Even more disturbing, wage inequality
has risen, with young men with high school diplomas, for example,
experiencing real wage losses of roughly 25 percent from 1971
to 1988. These trends have frustrated the aspirations of many
Americans.

Sen. Riegle pointed out that the decisions of the Federal Reserve
can add to the already considerable problems of working Americans
by raising unemployment, making it hard for them to support themselves
and their families, to land a good job when they leave school,
or switch jobs if they become dissatisfied with their current
employment. I agree. That's why I think stabilization policy is
importantto avoid huge swings in unemployment. When you
have the kind of recession we had in 1982 and 1983, for example,
you can see the visible toll it takes on households. Perhaps because
the causes and consequences of unemployment have been a focus
of my research, I consider it easy to remain mindful of the people
behind the numbers. In order to avoid high unemployment we must
be careful not to push the economy below the NAIRU, allowing inflation
to rise and to become embedded in expectations. Because when that
happens, it takes a period of above normal unemployment to lower
inflation. That's the painful lesson of the '70s. Even when it
comes to inflation we have to remember that prices per se do not
affect social welfare. Inflation matters because of its repercussions
on a country's economic performance, which in turn affects the
welfare of individuals. Why are we in this business? It seems
to me that it's to promote the well-being of American households.
That's what it's all about.

Region: An unidentified Fed official was quoted in the New York Times saying, "When the time comes to move
in the other direction and ease interest rates ... the Blinder-Yellen
analysis might be part of that change." Tell us about the Blinder-Yellen
analysis: real or perceived?

Yellen: I believe that the unidentified official may
have been referring to my concern, which I voice routinely in
interviews and speeches, with the implications of lags for the
appropriate conduct of monetary policy. One of the time-honored
truths of macroeconomics is that monetary policy operates with
long and variable lags. This implies that any policy change put
into place at a given time will continue to affect the economy
for a very long time into the future. The typical econometric
model, suggests, for example, that less than half of the impact
of a monetary policy change occurs during the first year. The
Fed, for that reason, has to be forward looking, implementing
policies well in advance so that they will begin to impact the
economy at the time they are needed.

Starting a year ago February, the Fed wisely began tightening
monetary policy, not because restraint was needed thenafter
all, inflation was falling and there was still substantial economic
slackbut because it was convinced that without laying the
groundwork, the economy would end up overheating, and inflation
would rise. It has taken a long time for those policies to have
a discernible impact. It is only during the last few months, I
think, that their impact on the interest-sensitive sectorsautos,
housing, consumer durableshas become apparent. This is not
really surprising, because the policy tightening averages only
eight or nine months in age. In the meantime, one has to wait,
without seeing much happen, and during that waiting period, the
assumption that the restraint in the pipeline will eventually
make itself felt requires an act of faith, based on past experience.
It's all too easy to lose faith that the policy will work and
to conclude that, for any of a number of reasons, past actions
just aren't having the expected impact. The consequence is that
monetary policy always faces the possibility of oversteeringtightening
too much when demand is growing too quickly and later loosening
too much when the economy has slackand getting the timing
all wrong. That's why Milton Friedman warned that monetary policy
can destabilize the economy.

Perhaps the unnamed Fed official drew the conclusion that one
day, when the time eventually comes to ease policy, the need for
such actions will not be apparent from current economic indicators
but instead will be based on a forecast of where things are headed.
Indeed, just as policy began to be tightened at a time when inflation
was falling and there remained excess capacity, it is conceivable,
using symmetric reasoning, that it will be right to begin loosening
even with the economy operating beyond potential or with inflation
rising.

Region: And in Blinder's case ...

Yellen: I can't speak for him, but I imagine that he
would agree. We've both given speeches in which we've made these
points. This line of reasoning leads to the idea that policy should
be altered conservatively, moderately. We should be careful not
to overdo policy swings. In the extreme, Milton Friedman would
have us do nothing. He would like the Fed to keep the dials fixed.
But I certainly wouldn't go that far, and I don't think Blinder
would either.

Region: When you were appointed to the Board of Governors
by President Clinton, there was a quite different political circumstance
than exists today. Has the change affected your role as a governor?

Yellen: I don't think it's affected my role as a governor.
Politics play virtually no role at all in the life of a Fed governor,
because, as you know, the Federal Reserve is an entirely apolitical
institution. With a 14-year term, a Fed governor has both the
luxury and duty to focus on the long term and to ignore politics.

Politics only matters insofar as it affects Congress' agenda
with respect to the banking industry and the Federal Reserve.
In that regard, the political changes do have implications both
for the Fed and the banking industry. As you undoubtedly know,
Glass-Steagall reform is one of the top priorities of Jim Leach,
the chairman of the House Banking Committee. Senator D'Amato,
chairman of the Senate Banking Committee, is also proposing reform
in this area, although the two committee chairs would approach
such reform in different ways. The Board is committed to the view
that banks should be allowed to engage in securities underwriting,
as long as this occurs with appropriate safeguards. We don't think
this activity is particularly risky, and there would be benefits
both for the industry and for consumers. Thus we welcome Congress'
interest in Glass-Steagall reform and have testified to this effect.
We are hoping for legislation in this area.

Regulatory burden is another area which is receiving a great
deal of attention in the new Congress and again, this is an area
of concern both to the Board and to the banking industry. Comprehensive
regulatory reduction bills geared to banking have been introduced
in both houses of Congress, and I am sure that the Board will
support many of the provisions of the bills as well as the overall
thrust of the legislation. It's a bit early to know just what
will happen with this legislation.

Region: As a follow-up question, compared to most other
political appointments, your political resume is virtually non-existent.
It seems that you were selected to serve on the Board on some
basis other than political. What do you think?

Yellen: Correct. I have no political resume whatever.
I'm a Democrat and I supported Clinton but I doubt that was the
reason for my appointment. I assume that I was appointed for my
expertise in economic analysis. I consider myself a pragmatic,
mainstream economist with a strong policy orientation. I have
spent most of my professional life teaching and conducting research
on labor markets and international issues in academic settings
and also, for a time, as an economist in the Division of International
Finance here at the Board. Having taught on the faculty of a business
school for the last 14 years, particularly in the fields of international
business and economics, I think that I have also developed a good
feeling for the ways in which the economic and regulatory environment
impacts businesses that are trying to compete in the global economy.
I assume that the president believed I would have the right toolkit
to analyze the issues confronting the Board, both with respect
to monetary policy and also in connection with regulatory issues.

Region: Before becoming a governor, you and your husband
[George Akerlof, professor, University of California, Berkeley]
collaborated on economic studies. What was the nature of your
work?

Yellen: We've done a lot of work together. We are probably
best known for our joint work on wage and price rigidity. A central
puzzle in macroeconomics is why wages and prices exhibit so much
inertia. We probably wouldn't need monetary policy at all if wages
and prices at the aggregate level adjusted very rapidly to clear
markets. But I think most people have arrived at the conclusion
that wages and prices just aren't that flexible. The question
is: Why not? My husband and I have written papers that analyze
this issue, focusing on the possibility that the payoff to individual
firms and workers from adjusting wages and prices may be so small
that they just don't botheror if they do, they adjust slowly.
And yet, even though such inertial behavior is not very costly
for individualswe call it "near rational"it adds up
to produce major costs at the aggregate level.

We've also focused a great deal on unemployment. Unemployment
is a puzzle for any economist. Why is it that labor markets seem
not to clear? Why is it that firms don't cut the wages of their
current employees when there are people outside their gates lining
up to fill out applications, offering to work and willing to accept
wages that are lower than the going pay of the current employees?

We're associated with a school of thought known as "efficiency
wage theory," which takes seriously the idea that firms' wage
policies impact the productivity and morale of workers and that
firms constantly take those impacts into account in setting and
changing wages. Firms don't just try to pay as little as possible
to get the needed bodies on board; when there is unemployment,
they ask themselves how wage cuts would affect the behavior of
the employees. Would they quit or feel dissatisfied and work less
hard on the firm's behalf if they feel that wage policies are
unfair?

My husband and I have also studied alternative measures of unemployment.
There was a period, during the late '70s and '80s, when the Phillips
curve seemed to be shifting. Inflation was higher than one would
have expected, looking at the traditional indicators like the
unemployment rate. We developed an alternative measure of unemployment,
based on recall data, to gain some insight into why the Phillips
curve had shifted.

We also did a large research project on German unification that
appeared in Brookings Papers on Economic Activity in spring 1991.
The paper attracted quite a bit of attention, because we analyzed
data on East German firms and forecast that, given the terms on
which unification had occurred and the subsequent behavior of
wages, only 10 percent of East German employment was in firms
which could cover their costs once they were forced to compete
in international markets. We developed a flexible wage subsidy
plan with built in sunset provisions to deal with the problems
which were certain to ensue. Our plan was vigorously debated,
but not ultimately adopted. More recently, we have focused on
American social problems including crime and the breakdown of
the family.

Region: Are husband and wife teams common?

Yellen: They're becoming more common. Actually our closest
friends at Berkeley are a husband and wife team who work on macroeconomics,
both together and individually. More women these days are waiting
longer to get married, and are meeting their respective mates
in graduate school or on the job, so it's natural. Women's lives
revolve more around the workplace, and that's how many relationships
are formed. In fact, I met my husband on the job, here at the
Board, at a lunch following a seminar. I was working in the International
Finance Division, and he was working in Research and Statistics,
on money demand.

Region: What kind of research should the Fed pursue?

Yellen: I believe that the Federal Reserve should have
a very broad research agenda, focusing both on basic and applied
questions. By allowing our economists considerable freedom to
research whatever questions are most intriguing, we attract the
very best talent to the Federal Reserve System, and that is the
System's greatest strength. There are so many puzzles relating
to macroeconomic performance that the potential range of research
topics with bearing on monetary policy is enormous: Why did productivity
growth slow starting in the 1970s and has it finally increased
again? Are there changes in the labor market related to global
competition which affect the inflationary process? Why is the
American savings rate so low? What explains the volatility of
asset prices? We spend our day looking at these asset prices on
the screen and trying to interpret what they might mean about
how people's expectations are being formed.

What we know from decades of research, and some of the most
important papers were written by Fed staff, is that asset prices
are simply too volatile. They move much more than is justified
by movements in the fundamentals. Why is that? What are the channels
through which monetary policy impacts investment and saving? Has
the transmission mechanism changed? How can we account for the
behavior of exchange rates in general and the weakness of the
dollar more recently? The list is endless. In addition, there
are so many regulatory questions, where research is useful in
the work we do. Fed economists should continue to study, for example,
the classic questions concerning structure, conduct and performance
in financial markets; to understand the incentives created by
deposit insurance and the safety net and so on. There are many
questions relating to derivatives and payments system risk, where
research is also having a high payoff. For example, research conducted
in the Federal Reserve System on the use of banks' internal models
to compute capital requirements is leading to innovative approaches
to the development of capital requirements oriented toward market
risk in bank trading portfolios. My list of good research topics
is endless.

Region: Do you make a distinction between Board research
and bank research in any way? Is it all just research to you?

Yellen: It's all research to me. I don't see that there's
any great difference between what we should be doing at the Board
and what should go on at the banks. A lot of the banks, including
your own, have outstanding research staff. In Minneapolis, you
have promoted and supported very basic research. It's quite interesting,
and I think a tribute to your research agenda, that so much of
it has ended up in my bookshelf. I don't agree with it all, but
it's extremely interesting.

Region: Earlier this year a group of U.S. senators released
a list of the 10 worst regulations. Among them were the Truth
in Lending Act and the Community Reinvestment Act [CRA]. Do you
have any reaction to the list now that you have had a chance to
work with these two sets of regulations?

Yellen: Clearly regulatory burden is a big issue for
banks. Bank regulations have become quite complex, and I think
that many banks, particularly smaller banks, are heavily burdened.

The CRA and Truth in Lending regulations rank high on bankers'
lists of burdensome regulations. In both cases, banks have confronted
the need for a lot of expensive paperwork and, in the case of
CRA, some genuine uncertainty as to what the regulations require.
Nevertheless, I think it should be clearly recognized that most
of the burden stems from the fact that the Fed is required by
law to write rules which insure compliance with legislation which
responds to very legitimate public policy concerns. The laws themselves
are complex; the statutes often provide for civil liability exposure;
and, therefore, institutions can't live with ambiguity in the
rules. The consequence is that regulations must be formulated
which are unambiguous and therefore complex.

We need to compare the benefits of regulations with the costs
that these regulations impose on the business community. In many
but not all cases, I believe that the benefits outweigh the costs.
CRA is a good example. Before CRA was passed, redlining was a
common practice, and some low- and moderate-income communities
faced difficulties gaining access to credit. You literally had
banks that were taking red pens and putting lines around certain
districts of the city where they wouldn't lend. That was their
policynot to lend. And I think that was a problem and it
was right for Congress to address that issue. The Community Reinvestment
Act made banks think quite hard about how to serve the needs of
these communities by devising new approachesnew products
tailored to the needs of these areas and new methods for marketing
these products. Many banks have discovered profitable ways of
serving these often neglected niches. So CRA has had some very
valuable effects. But CRA is also burdensome. And, as the regulators
have learned over the last several years, streamlining performance
measurement in a way which is fair to banks and to the communities
turns out to be fraught with hazards. In the case of CRA, I think
that the new regulations will offer greater clarity and certainty.
There will be streamlined procedures for small banks and clear
performance measurement to assure good performance rather than
just good process.

Region: Of those hobbies or reading interests or some
special projects or family sports, what would be interesting for
people to know about you?

Yellen: There is very little that is really interesting.
The truth is, if you spent an evening at our house you would probably
hear economics discussed over the dinner table. My husband and
I work together, we're both economists, and the bulk of our friends
are economists. You would eat a diet that is richer in discussions
of economics and policy issues than many people would find appetizing.
We have one son who is 13, and he has mentioned that he is also
thinking of becoming an economist.

We're a close-knit family and we spend a lot of time together.
We like to travel; we enjoy going to exotic spots. We prefer not
to mix work and play, but instead, to have relaxing family vacations
together. We all like to eat and cook.

Region: Any particular style of cooking?

Yellen: We enjoy ethnic food of all types. The range of culinary
possibilities in Berkeley is staggering, and that probably fueled our
interest. We like to entertain and to cook and my son's interested in
cooking too. And having lived in California, where the weather's nice
almost all year round, although we're not great athletes, we enjoy hiking
and tennis. I'm not ready for a match with the chairman, but I enjoy
knocking the ball around.

Region: And the exotic places that you've liked, any that you
could mention?

Yellen: We recently visited Kakadu National Park and
the outback in northern Australia to see the wildlife and aboriginal
art and sand paintings. We also spent time relaxing in French
Polynesiain Bora Bora and Huahine.

Region: Chatting with Board staffers, we learned that
you are considered among the most approachable of the governors.
How do you plead on that?

Yellen: I plead guilty. I like interacting with people.
Wouldn't you expect that to be the norm? I'm not sure why it should
be a surprise that a governor would be approachable.

I was a staffer here. I'm an economist. I share the same interests
as a large fraction of our staff. I enjoy hearing the details,
for example, about the economic forecast. I don't want to just
see the bottom line, the summary. I want to track the numbers;
I want to keep revisiting the key issues. Is inflation on track?
Do the models fit? What are the puzzles? Where are the risks?
Why is the dollar declining? And so I interact a lot with the
staff around such issues. This is the aspect of the job I enjoy
most.

Region: You were spotted up in the cafeteria or someone
who looked very much like you, so they say. That's a little uncommon
among governors isn't it?

Yellen: It is a bit uncommon, because the Board is a
somewhat hierarchical place. I can't frankly tell you why that
is. But that's not the way I operate. Eating in the cafeteria
with the staff is a pretty good way to learn what people are thinking
about, what's on their mind. And I enjoy the interaction.

Region: Betty Friedan,
in an earlier interview with The Region, emphasized
that economics is the basis for women's progress toward equality.
Does that square with your point of view?

Yellen: She's clearly right about the importance of economics
to women. Female labor force participation has increased enormously,
especially with slow wage growth and declining wages for less
educated men. Economics is a central motivator for women.

It seems to me that women have made an awful lot of progress,
but they probably remain under-represented, at the highest levels
of most organizations, for a variety of reasons. And it's probably
going to take a long time to change that.

I've had a lot of opportunities in my life. I don't feel that
I've faced discrimination. I've had every chance to succeed and
more, and I think that's what all women should have. Things are
changing; the playing field is becoming a lot more level. Certainly
Betty Friedan is right that economic issuesgetting the kind
of education and training that's necessary to have a career and
to succeed in the workplace, and juggling work and family responsibilitiesremain
central for most women.

Region: In the past you taught macroeconomics and international
economics to MBAs and executives. Of the macroeconomic concepts
you taught, which were the hardest to grasp for business people
of the present and future?

Yellen: That's an interesting question. Macroeconomics
is intuitively harder to understand than microeconomics, since
it concerns the interaction of many different markets simultaneously.
In the end, macroeconomics comes down to understanding how supply
and demand work in the economy as a whole, but it takes some time
before MBAs and executives can really understand, for example,
the transmission mechanism and how Fed policy affects the economy.
The determination of exchange rates and the relationship between
trade and capital movements in the international economy are also
particularly difficult for students to grasp. But then, although
we have a lot of interesting theories concerning exchange rates
and trade flows, the reality is that none of them really work,
so perhaps its natural for students to be confused.

Region: Back in the '70s you worked at the Federal Reserve
as a consultant to the Division of International Finance, and
then later as an economist in the same division and now you return.
I wonder if you can detect any fundamental differencesexcluding
those that might come from the current elevated perspective?

Yellen: To me the greatest asset of the Fed is the people.
We have a tremendously dedicated staff. I was here in 1977-78;
I came back 16 years later and found that most of the people I
worked with are still here. They're working just as hard as ever,
and there's a really good reason for it. It isn't an accident.
It's because the organization is really so well run and the staff
feel committed to it. They feel proud to work for the Fed, because
this is such a competent, professional and well-respected organization.
I feel proud of the organization too; I wouldn't have wanted to
come back unless I felt that way.

So have things changed? No, and it's wonderful they haven't
changed.

Region: Thank you, Ms. Yellen.

More about Janet Yellen

Most recently, she was the Bernard T. Rocca Jr. Professor
of International Business and Trade, University of California,
Berkeley; prior to that she was a professor and associate
professor at Berkeley.

She has been a lecturer at the London School of Economics,
an assistant professor of economics at Harvard, and an economist
in the Division of International Finance, Federal Reserve
Board of Governors.

Her prior government experiencein addition to her
work at the Boardincludes service on the Congressional
Budget Office's Panel of Economic Advisers and on several
review panels for the National Science Foundation. Doctorate,
Yale University, 1971; bachelor's degree, Brown University,
1967.

Best known for her work exploring the causes of wage and
price rigidity, her macroeconomic research also includes
work on unemployment and other wage issues; internationally,
she has studied issues concerning exchange rates, as well
as German monetary union and the impact on East German reconstruction.

Her papers include "Gang Behavior, Law Enforcement and
Community Values," (with George Akerlof), Values and
Public Policy, Brookings Institution, 1994; "The
Fair Wage/Effort Hypothesis and Unemployment," (with George
Akerlof), Quarterly Journal of Economics, May
1990; "Is There a J-Curve?" (with Andrew Rose), Journal
of Monetary Economics, July 1989; "Rational Models
of Irrational Behavior," (with George Akerlof), American
Economic Review, May 1988.